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An Introduction to
Digital Assets
How blockchain technology is
transforming our economy
and society in the 21st century
August 2021
Navigate this
presentation:
start
An Introduction to Digital Assets 2
Foreword
From a niche concept to a potential financial We know that people have a tendency to overestimate the
disruptor. More and more people are starting to impact of technology in the short-term and underestimate it
take an interest in cryptocurrencies, blockchain and in the medium to long-term, a phenomena known as
decentralised finance. Amara’s law. A few years have passed since that
conversation, and an amazing €200bn has been invested by
At the same time cryptocurrencies, and the blockchain global corporates into building blockchain and decentralised
concept that underpins them, are so often misunderstood. finance (DeFi) technology and platforms.
Is Bitcoin a currency? Will blockchain – a technology that
stands for decentralisation – democratise financial power? This topic is so rich and complex, and changes so rapidly,
Is this technology simply a game for enthusiasts, or do its that investors are seeking guidance and education. We have
applications stretch far beyond the technical aspects? done thorough research, spoken to a number of outspoken
These, and many more questions are often left unanswered experts and compiled this report to help you to understand
or inadequately addressed. and recognise how this new technology is transforming our
economy, and potentially our entire society, in the 21st
I was personally first introduced to the subject a few years Century.
ago, at a junior football match. I had a discussion with
another player’s father, who happens to work at Deutsche
Börse, the German stock exchange. At the time, I thought
that decentralised finance was something that existed in the
distant future, but I quickly realised how advanced it already
was, and how it would only be a matter of time before this Christian Hille – CIO Fürstlich Castell'sche Bank
would disrupt not only finance, but many other areas.
An Introduction to Digital Assets 3
Blockchain
Fundamentals Blockchain Applications
Towards a The emerging token economy
decentralised economy for payments, services and securities
to chapter to chapter
Environmental &
The Digital Social Impact
Asset Market Thinking “outside the blocks”
Blockchain’s place
in the financial system to chapter
to chapter
Learn more
Authors, references &
technical glossary
to appendix
An Introduction to Digital Assets 4
Blockchain
Fundamentals
Towards a
decentralised economy
”
How does a blockchain
work and how is it related
to our economic life?
Did
you
know
…?
learn more
An Introduction to Digital Assets / Blockchain Fundamentals 5
Did you know…?
Companies globally are Bitcoin‘s entire The market value of Coinbase
expected to spend approx. blockchain size is at initial public offering was
$ 20bn/year 338 Gigabytes $ 100bn
more than Deutsche Bank,
on blockchain technical comparable to streaming
Commerzbank and
services by 20241 85 HD movies on Netflix2
Deutsche Börse combined3
1) Mitic (2021)
2) Statista (2021) & Reinhardt (2021)
3) Hinchliffe (2021) & Bloomberg L.P.
An Introduction to Digital Assets / Blockchain Fundamentals 6
The origins: A quest for decentralisation (1/3)
On the 31st October 2008, less than two months The GFC – a turning point for trust and finance
after Lehman Brothers had filed for bankruptcy, Public confidence in US banking systems, % (Gallup, 2016)
a paper was sent out to a small mailing list of
computer science enthusiasts that would change 71
the course of economic history.
Bitcoin
Written by an unknown author under the pseudonym of
whitepaper
Satoshi Nakamoto, “Bitcoin: A Peer-to-Peer Electronic Cash (31 October 2008)
60
System” outlined a concept that disrupted the world of
banking and gave birth to a new capital market.
At a time when trust in the financial system was at the lowest
it had been in decades, the document outlined a fully 49
decentralised digital payment system — one that would no
longer rely on financial institutions at all.
38
At the core of the system proposed by Nakamoto was
a technology called blockchain.
26
15
1979 1984 1989 1994 1999 2004 2009 2014An Introduction to Digital Assets / Blockchain Fundamentals 7
The origins: A quest for decentralisation (2/3)
Bitcoin’s central proposition was a fully decentralised system that allows users to make exchanges via a
peer-to-peer network on the internet. Using the blockchain individuals can transact without the oversight
of a central authority.
To fully grasp how revolutionary this idea is, first we need
to understand how fundamentally the internet has evolved
Today‘s online universe
up to this point. An internet of information
“Across the world today there are
Documents
over 20 billion1 interconnected devices.”
The internet allows information to be passed directly Emails
between devices in the form of data such as emails, photos
or video streams. These digital objects can be replicated and
distributed infinitely without losing their informational value.
Media
1) IOT Analytics (2020)An Introduction to Digital Assets / Blockchain Fundamentals 8
The origins: A quest for decentralisation (3/3)
When it comes to economic interactions like banking, the entire system relies on scarcity.
A value sum of money – represented in the form of data – can’t simply be replicated and keep
the same value. In digital economies this is known as the double-spending problem.
To avoid double-spending, banks maintain central databases,
acting as an intermediary to ensure online transactions are
The next evolutionary step
legitimate. Crises such as the financial crash of 2008 highlighted An internet of assets?
the vulnerabilities of this centralised banking system, including
single points of failure, corruption, data inconsistencies and
settlement delays.
Documents Securities?
A blockchain is a decentralised database that records
transactions transparently, anonymously and securely. This
structure fundamentally replaces trust in authority with security
Emails
through encryption, allowing for the direct exchange of assets
in the same way that information is shared on the internet – Money?
without any intermediaries. Services?
The real implications of this concept could be massive.
MediaAn Introduction to Digital Assets / Blockchain Fundamentals 9
The journey of a Bitcoin transaction
Some vocabulary
1 2 3 4 5
“A peer-to-peer …
Alice wants to send A transaction file Alice authorises The network uses Bob‘s wallet is
− Bitcoin facilitates transactions in
Bob 1 bitcoin from is created containing and announces the Alice‘s openly known now allowed to
a fully decentralised way
her digital wallet. all relevant details. payment using her “public key“ to verify spend the
secret “private key“ that she is indeed transferred coins. − Users interact directly with one
password the owner of her another in an online network
wallet address. − Users keep a copy of the entire
transaction history (blockchain)
The transaction gets
added to the block- … immutable …
Alice1 chain record by
Bob1
− Blocks of transactions on the
Tx-1 active users through blockchain are linked in a
+ ID: Tx-1 Tx-1 a consensus-building securely encrypted sequence
+ From: Alice1
process. These
+
+
To: Bob1
Amount: 1 BTC “miners“ are − No user can manipulate the
rewarded with newly chain history as it would be
generated bitcoin. rejected upon comparison
with everyone else’s chain
Pending transactions pool:
Tx Tx
… auditable ledger.”
Bitcoin network: “mining“ − All transactions by all users are
Tx
publicly visible, since everyone
Tx - 1 Tx - 1
(consensus-building mechanism)
has a local blockchain copy
Tx
Tx Tx
Tx
− However, only encrypted user
addresses are stored – it is
Block difficult to impossible to identify
“Block chain“
456
the person behind an address
(transaction
Further details in appendix:
Block Block Block Block
history) 452 453 454 455
Learn more
1) Note: user names shown for illustration purposes only – transactions only involve pseudonymous user addresses (see explanation on the right)An Introduction to Digital Assets / Blockchain Fundamentals 10 Building consensus: Miners and validators In a decentralised network without central oversight, a consensus-building mechanism is required to avoid double-spending. This prevents manipulations of the blockchain with false or duplicate transactions, and is essential for its overall security. There are currently two major approaches to determine how blockchain network participants can come to a consensus about the state of the blockchain, and to verify and record new transactions: A Proof-of-Work (PoW) B Proof-of-Stake (PoS) − PoW schemes like Bitcoin require users (“miners”) to validate new − The PoS consensus mechanism does not require the users to solve entries to the blockchain. The miners commit computational a computational puzzle or have specialist hardware in order to resources to solve a complex mathematical puzzle. validate transactions. − As a reward, the miners get paid in the cryptocurrency they are − In this mechanism, users are called “validators”, because they “mining” (e.g., Bitcoin). Similarly to the extraction of resources validate transactions by depositing (“staking”) some amount of through real mining, this method is extremely energy-intensive. cryptocurrency from their own wallet. − As with gold or fossil fuels, Bitcoin is a limited resource. There will − As an incentive, validators are rewarded in the same currency. only ever be a maximum of 21m coins in circulation. This has been compared to earning interest on a bank deposit. − Proof-of-Work is the original and most widely used consensus − Proof-of-Stake is a lot less energy intensive than PoW but has mechanism. Bitcoin, Ether and most other applications currently so far only been tested on a relatively small scale. Ethereum has operate using this mechanism. announced to switch to PoS in the foreseeable future.
An Introduction to Digital Assets 11
Blockchain
Applications
The emerging token
economy for payments,
services and securities
Did
you
know
”How could blockchain
technology transform
economies and where will it
…? make the most impact?
learn moreAn Introduction to Digital Assets / Blockchain Applications 12
Did you know…?
“Digital art“ sold in the first
There are now more than There are blockchain-powered
half of 2021 was worth
Social
11,000 Networks $ 2.5bn
cryptocurrencies such as Steemit, GNU Social, comparable to half a year of
other than Bitcoin1 and Sapien Sotheby‘s auction revenues2
1) CoinMarketCap (2021)
2) Howcroft (2021) & Reimers (2021)An Introduction to Digital Assets / Blockchain Applications 13
Blockchain in practice: A taxonomy of tokens
Bitcoin was proposed as an alternative world currency, but the underlying blockchain technology is what
could potentially shape the future of money, government and business.
Two types of virtual objects that have emerged are standalone digital “coins” and “tokens” that are built on top of existing
blockchain platforms like Ethereum. They can be used in fundamentally different ways:
“Use” …
… “Pay”
Utility tokens provide access to specific
services or goods (e.g. as an event ticket or
Payment tokens are the purest form of for car sharing access), similar to vouchers.
cryptocurrencies, enabling the decentral Tokens They are bound to a single use case – for
transfer of digital money e.g. to purchase
instance, Uber tokens may be redeemed
goods and services.
for a ride but nothing else.
Bitcoin dominates this space but has inspired
many alternative “Altcoins” over time. Jump to section
Jump to section
“Own” …
Security tokens are very similar to utility tokens, but they
represent an investment in an asset that already has value,
e.g. company shares, bonds, or certificates.
Their key advantage is that issuers don’t have to securitise these
tokens through traditional clearing houses, registries etc.
Jump to sectionAn Introduction to Digital Assets / Blockchain Applications 14
“Pay” Decentralised currencies
Inspired by Bitcoin, today there are numerous Major payment-oriented cryptocurrencies1
cryptocurrencies available for payment transactions. By market capitalisation in USD bn (CoinMarketCap, July 2021)
748
These “Altcoins” run on their own blockchain and differ 750
in their technical implementations. For example, while 600
new Bitcoin blocks are “mined” every 10 minutes, Litecoin 450
produces blocks every 2.5 minutes. 300
268
150 62 52 30 27 27 12 9 9
0
Comparison of technical cryptocurrency features1
Bitcoin Ethereum Bitcoin Cash Litecoin Monero
Key value Original blockchain Native currency to Bitcoin protocol spin- Fast and secure Privacy coin focused
proposition and highly secure power the Ethereum off with larger blocks payments with short on enhanced user
private payments blockchain platform for higher scalability block creation time anonymity
Transactions/sec2 7 30 116 56 ∞
Ø transaction fees 2.67 USD 5.92 USDAn Introduction to Digital Assets / Blockchain Applications 15
“Pay” Stablecoins
Cryptocurrencies are infamous for their volatility. Crypto is significantly more volatile than stocks,
Many investors have become millionaires overnight, even during market crashes like Covid-191
only to see their wealth disappear weeks later. Rolling 6-month volatility in % of price mean
Stablecoins share many benefits of cryptocurrencies 120%
Bitcoin MSCI World Equity
(transparency, security, privacy) without their extreme 100%
price instability. 80%
This is because, similar to the Gold Standard in the 20th 60%
century, the value of stablecoins is pegged to other assets
40%
such as the US dollar, gold or cryptocurrency baskets. One
20%
drawback of this is that this backing is usually managed
by a central institution. 0%
2013 2014 2015 2016 2017 2018 2019 2020
Examples of stablecoins Concept: stablecoins vs. pure cryptocurrency value
Name Organisation Asset backing
BTC/USD
Tether Centralised USD currency
USD Coin Centralised USD currency
Binance USD Centralised USD currency
Stablecoin
DAI Decentralised Cryptocurrency basket
1) Bloomberg L.P. TimeAn Introduction to Digital Assets / Blockchain Applications 16
“Pay” Central Bank Digital Currencies
As we experience a global shift towards digital and mobile payment forms, central banks are exploring options to issue digital
currency directly to end consumers. These central bank digital currencies (CBDCs), which may or may not operate on
blockchain technology, would represent a huge change in the global monetary system.
Central Governance
The rationale for CBDCs
Cash (bank
− Increases financial inclusion: bringing the “unbanked”
notes & coins) into the payment system
− Effective monetary policy transmission with less
Central Bank
interferences
Digital − Potential efficiency gains by eliminating costly cash
Currencies? management processes
− Undercuts other digital currencies not managed through
Private online the central banking system
payments
Variants of CBDCs
Technology
Traditional
(offline)
Digital
Wholesale: For financial institutions’ central bank reserves
Retail: Digital cash issued to the public by the central bank
Outlook
Stablecoins CBDCs may push stablecoins out of the market, since they
provide a new low-volatility digital payment solution that is
already embedded in the existing financial system.
On the other hand, CBDCs are by definition highly
centralised. This represents a drastic departure from the
Cryptocurrencies
original vision for cryptocurrency, and is a development
that will undoubtedly face backlash from users.
Decentral NetworkAn Introduction to Digital Assets / Blockchain Applications 17
“Pay” Central Bank Digital Currencies
Currently, 86% of Central Banks worldwide are working on their own digital currencies.
Case | Digital Yuan
Bahamas + Research by the People’s Bank
of China (PBoC) began in 2014
Eastern Hong Kong
Caribbean followed by several large trials
Project phase
+ The digital Yuan is one of the
Singapore
Launched most advanced CBDC projects
Retail pilot ongoing
and likely to launch before the
Retail pilot completed
Winter Olympics in 2022
Retail research
Wholesale projects + Hybrid Architecture
N/A with distribution through
the financial sector
(banks and other institutions)
Case | Digital Euro + Based on both traditional
systems and blockchain (token)
+ In July 2021 the European Central Bank announced the launch of a CBDC project
technology for enabling offline
+ The goal is to provide a marketable product after a two year exploration phase, payments (further details have
with a decision on issuing a Digital Euro expected approx. in 2023 (launch would not been disclosed by the PBoC)
be expected in 2025-2026)
+ No decision yet regarding IT architecture, esp. the use of blockchain technologyAn Introduction to Digital Assets / Blockchain Applications 18
“Use” From digital currencies to services
Ethereum was launched in 2015. The inventor, a Russian-Canadian programmer called Vitalik Buterin, saw the
need for a cryptocurrency that had other applications besides payments. Instead, the blockchain concept is
used to exchange goods and services between users.
Ethereum has its own cryptocurrency (Ether), but it’s also an open platform for various decentralised applications (dApps) that
enable access to real goods and services through so-called “smart contracts”. Anyone can create these token applications on
top of the Ethereum blockchain.
More than 2.5k dApps built on Ethereum
Electricity Monthly new and cumulative count of decentralised apps
Charitable donor- exchange
recipient matching dApps built on
smart contracts
Platform &
Supply chain
blockchain
tracing
Marketplaces &
Car sharing
exchanges
tickets
Source: stateofthedapps.com, Goldman Sachs GIRAn Introduction to Digital Assets / Blockchain Applications 19
“Use” Smart contracts
Signing contracts online
How smart contracts work
The Ethereum smart contract platform can facilitate a quick and secure Illustrative concept on the Ethereum platform
transfer of access to assets – such as real estate, cars or electricity.
Smart contracts are small computer programs that automate
agreements between parties by having the contract conditions written Conditional payment
into their code. The contract is automatically executed and enforced
(e.g., payments released) once and only if all conditions have been met.
User Conditional delivery Owner
Smart contracts are stored on a blockchain – similar to cryptocurrency
transactions – making it impossible for either party to violate a contract.
This provides a new level of security for business relationships in a
decentralised economy as conceptually, there is no need for lawyers or
judicial systems to enforce contracts and resolve disputes.
Key Advantages: Use case
Energy Web Foundation (EWF)
− Saves time, money and reduces the margin of error.
− Ethereum provides a known framework with a core developer
team
− The Canadian Energy Web Foundation (EWF) already utilises smart
contracts to connect electricity suppliers (e.g. households with
Consumer Producer
solar installations) to consumers in a peer-to-peer trading network. Smart contract
The efficiency of decentralised energy grids promises to accelerate Pays producer Contains consumption and production Offers surplus
via network data and automatically executes the energy directly
a low-carbon, consumer-centric electricity system. conditional exchangeAn Introduction to Digital Assets / Blockchain Applications 20
“Own” Security and Non-fungible tokens
Security tokens – the future of investing? Non-fungible tokens – the future of owning?
A key area where blockchain has the potential to Unique assets such as artwork or exclusive
disrupt is financial markets. A security token is collectibles could become easily investible through
issued on a blockchain and represents a stake in an securitisation as “non-fungible tokens”.
external asset – like a business.
Unlike fungible assets (e.g., a $5 note), non-fungible tokens
Security tokens are managed by smart contracts, and allow are not interchangeable – they represent ownership of
for many traditionally time consuming and fallible processes unique or rare items and allow for people to own shares of a
to be automated. The blockchain provides a source of truth market that is traditionally hard to access.
that all parties can depend on.
“The most In March 2021 an artist known as “Beeple”
sold an NFT of his digital artwork for $69
famous artist
million at Christie’s, making him “among
you’ve never the top three most valuable living artists,”
heard of:” according to the auction house.
Advantages Potential use cases
− Simplifies trading of company shares − Securitising unique digital artwork
− Transfer of ownership can take place without a stockbroker − Collectibles such as “NBA Top Shots”:
or notary public A blockchain-based platform that allows fans to buy, sell
− Small companies can raise capital without being listed and trade officially-licensed video highlights.
on the stock exchange − In the future we might see the tokenised ownership of
− Private investors get an easy option to participate in “start-ups” physical items, such as fashion items or cars
and to sell these participations at any timeAn Introduction to Digital Assets 21
The Digital Asset Market
Blockchain’s place in the financial system
Did
”
Are crypto assets an entirely new asset class,
and does this present an investment opportunity?
you
know
…?
learn moreAn Introduction to Digital Assets / The Digital Asset Market 22
Did you know…?
$100 invested in Bitcoin in 2011
Price volatility of Bitcoin is Of all Ethereum transactions
are now worth1
$ 6.1mn 4.7x 90%
go into decentralised
of Global Equity markets2
Finance (DeFi) applications3
1) Own calculations, Bloomberg L.P.
2) Based on weekly returns (Bloomberg L.P., Deutsche Bank AG, as of April 2021)
3) BeInCrypto (2020)An Introduction to Digital Assets / The Digital Asset Market 23
Between hype and paradigm shift
After over a decade of investment bubbles, fear-of-missing-out, bull-runs and crashes,
we are starting to see the increasing adoption and institutionalisation of digital assets.
A history of enthusiasm and fear Public interest in Bitcoin over time
− Emergence of digital assets with the publication of the Bitcoin Google searches of bitcoin-related topics relative to peak in 2018
whitepaper at the end of 2008
− Early market players mostly technology enthusiasts and Fintechs
− Extreme phases of hype cycles and crashes,
e.g. the ICO bubble of 2017
− Bitcoin gains a reputation for illegitimate transactions on the dark web
while seeing more and more adoption for legitimate use cases
Source: Google Trends data, Deutsche Bank, data as of April 2021
Where we stand & where we are headed Amara’s law
− Bitcoin still dominates the digital asset niche market although How we estimate the impact
large-scale adoption is continuously increasing
Impact of technology
of a new technology
− Growing number of established institutional investors in the market Actual technology-driven productivity
− Economists expect the “token economy” of blockchain to boost
global GDP by 1.76trn USD, or +1.4% until the year 20301
− Boston Consulting Group believes digital assets “could become the
biggest financial asset by the end of the decade”
Time
1) PricewaterhouseCoopers (2020)An Introduction to Digital Assets / The Digital Asset Market 24
Measuring up the digital asset market
Since 2018, the value of one Bitcoin has Putting the market in perspective
Market capitalisation of major global asset classes
increased 17 fold. In part because of the
$1.5trn Crypto market
media attention and hype around
cryptocurrencies and blockchain, this
$7trn
FAANG
$11trn $35tn
Gold
technology has become a major topic in Money (M1)
financial markets and the public.
However, this picture should not distract from
the reality that Bitcoin and other cryptocurrencies $81trn $90trn
currently make up only a tiny fraction of global Global Global $253trn
markets. GDP Equities Global Debt
The key questions for investors, regulators and
users remain: Bitcoin is signifcantly more volatile than other traditional assets
Based on rolling weekly returns, % calculated over the last 5 years
“Are crypto assets a separate 100
85%
new asset class?” 80
Peak equity market volatility for reference (2020)
60
“ Can they reasonably be considered 40
for diversified portfolios?” 18%
20 15% 13%
5%
0
Bitcoin Global Equities Gold USD HY bonds USD IG bonds
Source: Bloomberg L.P., Deutsche Bank, data as of April 2021An Introduction to Digital Assets / The Digital Asset Market 25
Is Bitcoin an asset class or a currency?
Assigning cryptocurrencies to an existing or new asset class requires a look under the hood to examine
their features. Intuitively, one might view these “coins” and “payment tokens“ simply as currencies. Yet they
struggle to meet the economic criteria of what constitutes money (a medium of exchange, unit of account
and store of value). Meanwhile, evidence on the diversification potential vs. other asset classes is mixed.
Functional characteristics
1 Medium of exchange 2 Unit of account 3 Store of value 4 Safe haven/anti-cyclical
Assessment
Transactions per second (approx.) Rolling 6-month volatility in % of mean price BTC ETH Brent Gold DAX MSCI AMZN GOOG
BTC 1.00
1,700 Bitcoin MSCI World Equity ETH 0.59 1.00
1,500 100%
Brent 0.21 0.08 1.00
1,000 Gold 0.01 0.03 -0.29 1.00
50% DAX 0.25 0.26 0.62 -0.16 1.00
500 174 193
4.6 MSCI 0.25 0.25 0.63 -0.15 0.99 1.00
0 0% AMZN 0.03 0.11 0.06 0.11 0.34 0.37 1.00
Bitcoin SWIFT PayPal VISA 2013 2014 2015 2016 2017 2018 2019 2020 GOOG 0.16 0.18 0.28 -0.05 0.46 0.48 0.45 1.00
Bitcoin is already used to make Because Bitcoin so far is rather Volatility is also a key obstacle The disconnect between digital
exchanges between users; however, disconnected from the real for using cryptocurrencies as assets and the real economy
its widespread adoption has caused economy, there is no market savings – there is no guarantee may prove useful. Many point to
severe delays in transaction consensus (equilibrium) of what of what your wealth will be low correlations with traditional
processing. Solutions have been certain goods and services worth in the future. On the other asset classes, suggesting that
developed within the Bitcoin should cost in cryptocurrency hand, Bitcoin has been used by crypto investments may be used
protocol and in the form of Altcoins, terms. This lack of reference many as a buy-and-hold to diversify investment portfolios.
but scalability remains a critical creates price volatility, rendering investment, and so far has kept Cryptocurrencies have been
challenge. their practical application difficult appreciating in value over long used as a gold-like safe haven in
(imagine shops having to adjust time spans. Cryptocurrencies are times of market crises.
their price tags every few used by many to evade capital
minutes!) restrictions and dispossession.An Introduction to Digital Assets / The Digital Asset Market 26
Investing in digital assets
Investors in cryptocurrencies have enjoyed massive Performance since 2013: Bitcoin and Ethereum
in USD
returns. However, all major tokens have experienced
70,000 4,900
extended period of large-scale losses, making BTC (lhs) ETH (rhs)
blockchain-related investments challenging. 60,000 4,200
50,000 3,500
On a fundamental level, investors can enter the market by
directly buying and holding Bitcoin, Ethereum or any other 40,000 2,800
combination of altcoins and tokens. 30,000 2,100
More recently, derivatives and passive investment vehicles 20,000 1,400
have started to emerge in line with increasing institutional 10,000 700
interest and adoption. 0 0
2013 2014 2015 2016 2017 2018 2019 2020 2021
There are also a strategies of actively managed investments in
the crypto space, which require a comprehensive review and
analysis of their own.1 Historical drawdown: Bitcoin and Ethereum
Relative price difference to last peak
Further, investors can make use of staking as a strategy that 0%
effectively earns interest in crypto currency and can be a
-20%
lucrative complementary investment strategy.
-40%
Comparing staking returns to traditional interest deposits -60%
0.40 % p.a. 13.29 % p.a. -80%
-100%
ETH BTC
Bank deposit rate Staking reward (delegated)
(United Kingdom) (Polkadot) 2013 2014 2015 2016 2017 2018 2019 2020 2021
1) Castell’s experienced PM team has screened the available universe and has selected a few sustainable strategies as appropriate for investments in long-term portfoliosAn Introduction to Digital Assets / The Digital Asset Market 27
The market for Decentralised Finance
Recent years brought the emergence of blockchain-based Development of the DeFi market
Left scale “total value locked (TLV)“ in USD, right scale “user“
instruments in what is known as “decentralised finance” (DeFi).
Removing intermediaries from financial transactions allows not 100,000m 3.5m
just the transfer of money, but also lending activities or entirely 80,000m
TVL Users
3.0m
new financial activities, such as liquidity mining and yield farming. 2.5m
60,000m
Nearly all DeFi applications are built on the Ethereum blockchain using smart 2.0m
contracts without any centralised company or governance body. Instead of 40,000m 1.5m
the decentralisation of money, DeFi aims for the broader decentralisation of 1.0m
20,000m
the traditional financial industry and giving access to the population of 1.7bn 0.5m
“unbanked” people. DeFi is also emerging as a tool for smaller businesses in 0m 0.0m
07|17 07|18 07|19 07|20
developing markets, especially for remittances and small loans.
Digital replications of existing financial activities Novel financial activities
Exchanges & barter trading Atomic swaps
Simultaneous execution of transaction parts (delivery versus payment)
Borrowing & lending Flash loans
Extremely short-termed loans used for arbitrage and portfolio reallocations
Derivatives & options
Staking
Participating in proof-of-stake validation processes and earning
Asset management interest-like rewards in the form of newly created coins
Yield farming / liquidity mining
% Active optimisation of investment returns through constantly shifting assets
Non-fungible tokens and earning rewards from e.g. providing liquidity in exchange pools or
Digital art, in-game items, virtual land sales etc. lending out cryptocurrency to other usersAn Introduction to Digital Assets 28
Environmental &
Social Impact
Thinking “outside the blocks”
Did
you
know
…?
”
What are the environmental
and social implications
of blockchain technology?
learn moreAn Introduction to Digital Assets / Environmental & Social Impact 29
Did you know…?
The entire bitcoin network Of all invested assets Of all cryptocurrency
could be powered for in the US today transactions
1.9 years 33% 0.34%
with the annual electricity are managed in accordance
are estimated
consumption of always-on with environmental, social
to be connected to
but inactive home devices and governance (ESG)
illicit activities3
in the US alone1 considerations2
1) CBECI (2021)
2) Nason (2020)
3) Chainalysis (2021)An Introduction to Digital Assets / Environmental & Social Impact 30
The environmental costs of decentralisation
Bitcoin currently consumes huge amounts of energy and has a significant carbon footprint. At a time when
increasing emphasis is being placed on mitigating climate change, the sustainability profile of blockchain
technology is a major concern.
The high energy consumption is a “flaw” that was intentionally designed into the Bitcoin system, since Proof-of-Work consensus
mechanisms rely on the block mining process to be computationally difficult and resource-intensive. However, several solutions
have been put forward already to mitigate these issues.
! Identified issues Approaches / solutions
Electricity consumption (TWh/year)
1 Energy mix
Volcanoes and natural springs in Iceland have provided a
cheap source of natural energy. 8% of all Bitcoins have been
12 111 116 124 161 205 mined there using this renewable energy1 – yet the vast
majority of Bitcoin mining takes place in China, the US and
Google Nether- Bitcoin Norway State of World‘s Data Russia, countries that are still heavily reliant on fossil fuels.
lands New York Centers
2 Consensus protocol
Footprint of a single Bitcoin transaction1 In recent years, the Ethereum project has made steps to move
to a Proof-of-Stake consensus mechanism that would replace
Carbon emissions Electricity Electronic waste compu-tational effort with a staking system, reducing energy
811kg CO 1,708kWh 83.1g
consumption.
2 3 Using the work of Proof-of-Work
equivalent to 1.8 million equivalent to 59 days of equivalent
Other ideas include sticking to Proof-of-Work schemes but utilising
VISA transactions power consumption in an to 1.3 batteries
the invested computational power to solve complex scientific
average US household
problems, e.g. in medicine or physics research. One small pilot is
currently run in the US as “fold@home”.
1) Digiconomist (2021)An Introduction to Digital Assets / Environmental & Social Impact 31
Social implications of blockchain technology
Blockchain technology addresses concepts at the very core of our social and economic life –
the formation of trust and authority. Similar to the environmental debate, there are societal implications
that would arise from wide-spread adoption of cryptocurrencies and tokens.
! Risks & threats Benefits & opportunities
− Many blockchain projects in practice are developed and operated − Decentralised governance eliminates risks of centralisation,
by centralised organisations with commercial motives, such as corruption and technical or administrative failure
counteracting the original ideas of blockchain − Security: Money laundering or identity fraud become more
− CBDCs entail risks for data privacy and potential threats regarding difficult in a public system where transactions can be
surveillance of consumer spending systematically tracked to its origins
− The pseudonymous nature of some cryptocurrencies could make − Ability to make supply chains more transparent in the future,
identifying things like political donations and fraud more difficult for instance through better records of where supplies are
− Cryptocurrencies play a central role to various criminal activities. sourced from, kept and ultimately used
Bitcoin remains the primary payment currency in the dark web − Decentralisation of economic power comparable to the
invention of open source knowledge databases (Wikipedia)
Illegal activities connected to cryptocurrencies
− Inclusion: Possibility for the “unbanked” to access financial
Value and share of transactions linked to illicit uses
services using only a mobile phone and the internet
25 5.0%
Total transaction value, bn EUR (lhs)
20 4.0%
Share of all transactions, % (rhs)
15 3.0%
1.7bn people “unbanked”
10 2.0%
5 1.0%
22% without access to the banking system)
0 0.0%
2017 2018 2019 2020
1) Chainalysis (2021)An Introduction to Digital Assets 32
We are in an exciting era of knowledge democratisation.
Closing thoughts
30 years ago, who would have predicted that a decentralised
encyclopaedia written by readers themselves would beat Brockhaus
in terms of accuracy and quality? In the age of the internet,
knowledge is in the hands of anyone with access to Wikipedia.
As the old adage goes: “knowledge is power.” Whilst the internet had
democratised knowledge, blockchain is democratising power. As we
”
have seen, blockchain offers the opportunity to completely remove
the middleman for the first time, allowing all sorts of financial
Blockchain is about processes to be transparently and securely managed on a peer-to-
peer network. This technology offers more people access to financial
decentralisation and services and creates a new ecosystem of digital assets. This is the real
democratising power. potential of blockchain.
It’s still early days for this emerging market. Coins and tokens are
It will change the way highly volatile, and the competition between the official central bank
digital currencies and private decentralised systems has only just
we do business in the begun.
21st century. From accelerating the transition to renewable energy to creating a
market for carbon offsetting, the stage is set for this technology to
unleash great innovation and ingenuity over the next decades.
Perhaps, at the same time, creating more equal and open markets
and societies, and transforming the fundamental structures of our
economic life.
— Christian HilleAn Introduction to Digital Assets 33
Appendix
Authors, references &
technical glossaryAn Introduction to Digital Assets / Authors and Acknowledgements 34 Authors Christian Hille Nils Mallock Lukas Kreß CIO Fürstlich Castell‘sche Bank, Portfolio Management Product Management Head of Portfolio Management Acknowledgments We would like to thank everyone involved, internally and externally, for bringing this comprehensive publication together. Special acknowledgement goes to Katharina Gehra and Walther Doernte for their valuable insights and very constructive, critical discussions around blockchain and its applications, as well as journalist Tarn Rodgers Johns for her professional writing services.
An Introduction to Digital Assets / Appendix 35
References
Auer, R., Cornell, G., Frost, J. (2021). Rise of Central Bank Digital currencies: Dirvers, Hinchliffe, R. (2021). Coinbase IPO values hits $99.6bn valuation with shares up 52% on
approaches and technologies. BIS working paper, No. 880. debut.
BeInCrypto (2020). DeFi Accounts for Almost 90% of Ethereum Transactions. Howcroft, E. (2021). NFT sales volume surges to $2.5 bln in 2021 first half.
Blockchaincenter.net (2021). Various Articles. IOT Analytics (2020). State of the IoT 2020.
Cambridge Bitcoin Electricity Consumption Index CBECI (2021). Comparisons. Mitic, I. (2021). 45 Blockchain Statistics & Facts That Will Make You Think: The Dawn of
Hypercapitalism.
Chainalysis (2021). Crypto Crime Summarized: Scams and Darknet Markets Dominated
2020 by Revenue, But Ransomware Is the Bigger Story. Morgan Stanley (2021). Update: Bitcoin, Crypto and Digital Currencies.
Chainalysis (2021). Cryptocurrency Ecosystem Comparison: Bitcoin vs. Ethereum vs. Nason, D. (2020). ‘Sustainable investing’ is surging, accounting for 33% of total U.S. assets
Stablecoins. under management.
CoinMarketCap (2021). Various data. PricewaterhouseCoopers (2020). Time for trust.
DappRadar (2021). Various Reports and Articles. Reimers, A. (2021). Das Credo heisst online Bilanz der internationalen Auktionshäuser.
Digiconomist (2021). Bitcoin Energy Consumption Index. Reinhardt, A. (2021). Ratgeber: So viel Speicherplatz sollte Ihr Smartphone haben.
Defi Pulse (2021). Total Value Locked (USD). Sandner, P. (2019). Decentralized Finance (DeFi): What Do You Need To Know?
Ethereum Foundation (2021). Stablecoins. Schär, F. (2021). Decentralized Finance: On Blockchain- and Smart Contract-Based
Financial Markets.
Ethereum Foundation (2021). Dezentrale Anwendungen (DAPPS).
Statista (2021). Size of the Bitcoin blockchain from January 2009 to July 12, 2021.
Ethereum Foundation (2021). Decentralized finance (DeFi).
The Block (2021). Various data.
Ethereum Foundation (2021). Non-fungible tokens (NFT).
Gallup (2016). Americans' Confidence in Banks Still Languishing Below 30%.
Goldman Sachs (2021). Crypto: A New Asset Class?
Gulley, A. (2021). Understanding Ethereum.
Harris, M. (2017). A Few Bitcoin Statistics and Similarities to Equities.Back An Introduction to Digital Assets / Appendix 36 Further technical information Crypto wallet A software that enables you to send and receive cryptocurrencies, such as Bitcoin and Ether. Wallets can be web-based, similar to an online banking account (“hot wallet”) or offline in the form of encrypted USB memory sticks or even written down on paper (“cold wallet”). Setting up a wallet is a prerequisite to send and receive cryptocurrencies. Wallets contain user addresses which uniquely identifies them in the network. In public blockchains like Bitcoin, network participants can look up each and every past transaction an address has been involved in: see for yourself! Private & public key To use cryptocurrencies in their wallets, users generate a random pair of keys that are essential elements of blockchain security. The public key is the basis for the openly known user address that is used as the sender or receiver ID in the network. The private key can be understood as a secret passcode that is used to authorise transactions made with the public key (address). The two keys are mathematically linked in a way that allows for the user to generate a digital signature with them. Signatures are included with every transaction to prove that the sender knows the private key belonging to the public key (address) – in other words, that they are the rightful owner of the coins to be spent. Importantly, deriving the private key from the public key is impossible. It is critical that users do not lose or disclose their private keys – otherwise, the coins and tokens linked to their address will be lost forever. In practice, key pairs are usually stored within a user’s wallet and secured by encryption. Proof-of-Work mining & block generation In order to be rewarded with newly created cryptocurrency and transaction fees, active network users compete in a race to add new blocks of transaction data to the blockchain in a process called “mining”. Under a Proof-of-Work regime, miners continuously generate large random numbers until they find a value in a target range. This range is automatically adjusted to keep the PoW puzzle difficult and account for changes in the number of miners and computational resources invested.
An Introduction to Digital Assets / Appendix 37
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